CDs let me rest easy. Roughly 10% of my net worth is in CDs and other stable instruments currently yielding a blended rate of around 3.5% in 2H 2015. Even with rates so low, if I invest $250,000 at 2.3% I still earn $479 a month, which is a very nice chunk of guaranteed change for someone who no longer works for a living.
There are times when the 10-year yield might be yielding less than a similar duration CD. Look to invest in CDs to take advantage of such a spread. For example, the 10-year bond yield might yield 2.1%, while you can find 7-year CDs yielding 2.3%.
REASONS WHY I INVEST IN CDs DESPITE LOW RATES
* As long as I’m making money, I will have a steady inflow of excess cash given I save over 50% of my after tax income a month. If rates go up, I’m just going to invest in a higher yielding CD for the longest duration possible. It’s not like I’m one and done. The CD ladder is forever growing so long as I have income.
* Accrued interest is accessible. In the event that I no longer have income and no longer have any savings, all the accrued interest earned from my CDs can be withdrawn and used penalty free.
* CDs are 100% backed by the FDIC up to $250,000 per person on the account. I don’t have to worry about some corporate CEO scandal or competitive threats blowing up my specific stock. As a result, I can focus on more productive things.
* CDs offer a much higher interest yield than money markets. People complain about sub 2% CD interest rates when they are in effect 5-10X higher than money market interest rates at 0.2%-0.3%. Money markets are the real travesty! I’ve left the majority of my money in a money market for two months earning 0.3% a year which didn’t feel optimal.
* Diversification is important. Throwing 30% of my recurring savings in CDs is prudent, leaving me with 70% to invest in the stock market, real estate market, or in myself. It was fun buying Facebook for a 30% gain. But I’m under no delusion I will continue to get lucky. I also keep my single stock investments to around $25,000 due to my risk metrics. I’m unwilling to invest in Treasuries because of how high they’ve risen already and their lower rates than CDs.
* Passive guaranteed income is becoming more valuable. Right now I’ve got about $2,800 a month in CD interest income. If I threw the entire $250,000 in an Ally CD, my CD income would rise to ~$3,000 a month. With $3,000 a month in guaranteed income for the next several years, I know I will not be begging on the streets if I fail at entrepreneurship. Having the CD interest income safety net helps give me the confidence to create my own luck.
* I’m not greedy. Everybody says that inflation will eat away at my earnings. True, but my absolute capital is still going up with CDs. I’d rather make 1.59% on a CD than lose 5% in the stock market. Interest rates and inflation are tied together. You don’t have high inflation without high interest rates and vice versa. Once you build your nut to live off, you will do everything you can to perserve it because it took so long to build.
* Focusing on my X Factor. Given I’ve got the energy right now, I’m all about focusing on my X Factor. The X Factor is in all of us. We just have to unleash the beast. Often times, we can’t because we’re worried about school, money, family, etc. By putting my money in CDs, I just don’t worry about the funds at all anymore. I can then focus more of my time on my online work, my upcoming book, and other projects that provide MUCH GREATER returns than everything else!
RATES WILL STAY LOW FOR A WHILE
It’s important to get over the fact that the absolute rates are low and look at things relative to other things. When I was investing in 4.5% CDs, people were laughing at me for being so conservative. Well they sure as hell weren’t laughing after they lost 30-50% of the value in the stock market! And they sure as hell weren’t laughing when they lost their jobs due to the implosion in corporate earnings.
We are in an environment of incredible volatility and risk. Rates are expected to go up in 2016 and beyond. Greece almost defaulted. China’s stock market took a 30% tumble. Meanwhile, what’s going with Puerto Rico’s debt issues? I’d much rather make 2.2%+ on my money in a CD than 0.3% in a money market account. Furthermore, I’d much rather make 0.3% on my money than LOSE money in the stock markets. Everything is always relative and rates are low because borrowing costs are also low.
If you are a prodigious saver, are willing to keep your money safe for a set duration of time while earning an interest rate above the current risk free rate 10 Year Treasury, and are concurrently investing in other more aggressive instruments, I recommend diversifying your capital into a 5-year CD account or longer duration. All three of my CDs are currently with USAA, a firm I’ve banked with for 20 years.
Putting 10% of my net worth in long duration CDs has been one of the absolute best things I could have done for the past 13 years. $100,000 invested 7 years ago at a 4% compounded rate of return is now worth 32% more. I will continue to invest 30 cents for every single dollar I earn in CDs for as long as I make money. I sleep well every night knowing my money will always be there and is getting the best relative return.
RECOMMENDATIONS FOR BUILDING WEALTH
* Manage Your Finances In One Place: Get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize. Before Personal Capital, I had to log into eight different systems to track 32 different accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into Personal Capital to see how my stock accounts are doing, when my CDs are expiring, and how my net worth is progressing. I can even keep track of my spending.
One of their best feature is the 401K Fee Analyzer which is saving me $1,700+ a year in portfolio fees I had no idea I was paying. They also launched their incredible Retirement Planning Calculator pulling in real data to output as realistic a financial scenario as possible for your future using Monte Carlo simulations. I definitely recommend you run through your numbers, input different expense and income variables and see how you stack up. There is no better free tool online that I’ve found today. It takes a minute to sign up.
* Invest In Ideas Not Stocks: Motif Investing allows you to build a basket of up to 30 positions for only $9.95, instead of pay $8 for each. It’s changing the way people invest as they have 200 professional built Motifs to choose from, as well as thousands of others the community has already built. My problem is that I used to be tempted to day trade a lot. Not any more, and that’s a good thing. It’s important to let your positions play out.
* Mobilize Your Idle Cash: Wealthfront is an excellent algorithmic advisory choice for those who want the lowest fees and can’t be bothered with actively managing their money themselves once they’ve gone through the discovery process. In the long run, it is very hard to outperform any index, therefore, the key is to pay the lowest fees possible while being invested in the market. Wealthfront charges $0 in fees for the first $10,000, only 0.25% for any money over $10,000, and only have a $500 minimum to get started. Invest your idle money cheaply, instead of letting it lose purchasing power due to inflation.
Updated for 2016 and beyond. The bull market is alive and well. Don’t forget to rebalance and manage your risk exposure. Everybody feels like a genius during good times.
About the Author: Sam began investing his own money ever since he first opened a Charles Schwab brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college on Wall Street. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 35 largely due to his investments that now generate over six figures a year in passive income. Sam now spends his time playing tennis, spending time with family, and writing online to help others achieve financial freedom.